Scientists & Engineers for America

Alternative Fuels and Advanced Technology Vehicles

Current Issues

Recent events have renewed interest in alternative fuels and advanced vehicles. For example, high pump prices for gasoline and diesel fuel have raised concerns over fuel conservation and energy security, including U.S. dependency on oil imports. In light of this, there is growing interest in more efficient vehicles or vehicles that abandon the use of petroleum altogether. This is especially true as the rapid growth in the sales of light trucks — these include sport utility vehicles (SUVs), mini-vans, and pickups, which tend to have lower fuel economy than passenger cars — has lowered the overall fuel economy of the new vehicle fleet.

Furthermore, ongoing technological developments in hybrid vehicles, ethanol fuel, fuel cells, and hydrogen fuel have raised key policy questions. These questions include whether more generous tax incentives for hybrid and/or fuel cell vehicles should be established, the costs and environmental impacts associated with production of ethanol or hydrogen as major transportation fuels, and whether research and development funds should be focused on such potentially high-risk technologies as fuel cells or on near-term technologies, such as hybrids.

Hurricanes along the Gulf Coast in the fall of 2005 led to fuel supply disruptions and high retail prices, raising congressional interest in alternatives to petroleum. In addition, in spring 2006, high crude prices, issues with refining capacity, and concerns about ethanol supply led to high pump prices, further raising concerns about the United States’ ability to supply fuel to the transportation sector.

Fuel Tax Incentives

There are three key tax incentives for alternative fuels: (1) a tax credit for ethanol of $0.51 per gallon, (2) a tax credit for biodiesel and renewable diesel of $1.00 per gallon ($0.50 for biodiesel made from recycled products), and (3) a credit of $0.50 per gallon for the retail sale of alternative fuels other than ethanol and biodiesel (e.g., LPG). In addition, there are tax credits for small ethanol and biodiesel producers ($0.10 per gallon).There is ongoing interest in tax incentives for the production and purchase of alternative fuels. Supporters of this approach argue that the market favors conventional fuels, and that the widespread infrastructure and nearly ubiquitous use of conventional fuels in automobiles makes it difficult for alternative fuels to compete without economic incentives. The American Jobs Creation Act of 2004 (P.L. 108-357) replaced a previous excise tax exemption for ethanol-blended fuels with a tax credit of $0.51 per gallon. This credit will expire at the end of 2010.

In addition to the credit for ethanol-blended gasoline, there has been interest in promoting biodiesel fuel. P.L. 108-357 provides a tax credit of $1.00 per gallon for the sale and use of “agri-biodiesel” — biodiesel produced from virgin agricultural products such as soybean or canola oil. There is a smaller credit of $0.50 per gallon for biodiesel produced from recycled grease. Under P.L. 108-357 the biodiesel credit would have expired at the end of 2006, four years before the expiration of the ethanol credit; the Energy Policy Act of 2005 (P.L. 109-58) extended the biodiesel tax credit through 2008. In addition, P.L. 109-58 expanded the credit to include “renewable diesel,” which is produced from a different process than biodiesel and results in a fuel with somewhat different chemical characteristics. In recent guidance on the tax credit, the Internal Revenue Service ruled that renewable diesel includes synthetic diesel fuel produced from vegetable oils at petroleum refineries. Most biodiesel producers are small plants. Many biodiesel producers are concerned that this decision could lead to a shift away from biodiesel production to renewable diesel production at large refineries.

Ethanol and MTBE

Outside of tax incentives, ethanol has been of key interest in recent Congresses, especially in its role as an alternative to MTBE (methyl tertiary butyl ether).7 MTBE and ethanol were used (among other purposes) to meet Clean Air Act requirements that reformulated gasoline (RFG), sold in the nation’s worst ozone nonattainment areas, contain at least 2% oxygen (by weight), to improve combustion. Under the RFG program, areas with “severe” or “extreme” ozone pollution (90 counties with
a combined population of 64.8 million8) must use reformulated gas; areas with less severe ozone pollution may opt into the program as well, and many have. In all, portions of 17 states and the District of Columbia use RFG, and about 30% of the gasoline sold in the United States is RFG, according to the Environmental Protection Agency (EPA).Before amendment by the Energy Policy Act of 2005, the Clean Air Act required that RFG contain at least 2% oxygen by weight. Refiners met this requirement by adding a number of ethers or alcohols, any of which contains oxygen and other elements. Until recently, the most commonly used oxygenate was MTBE because it was cheaper and easier to use than competing oxygenates. In 1999, 87% of RFG contained MTBE, a number reduced to about 46% in 2004, according to EPA. MTBE has also been used since the late 1970s in non-reformulated gasoline as an octane enhancer, at lower concentrations. As a result, gasoline with MTBE has been used throughout the United States, whether or not an area has been subject to RFG requirements.

MTBE contamination creates taste and odor problems in water at very low concentrations, and some animal studies indicate MTBE may pose a cancer risk to humans. MTBE leaks, generally from underground gasoline storage tanks, have been implicated in numerous incidents of ground water contamination. For these reasons, 25 states have taken steps to ban or limit its use, according to the Renewable Fuels Association. The most significant of the bans (in California and New York) took effect at the end of 2003, leading many to suggest that Congress revisit the issue to modify the oxygenate requirement and set more uniform national requirements regarding MTBE and its potential replacements, principally ethanol. Support for eliminating the oxygenate requirement on a nationwide basis was widespread among states, the petroleum industry, and some environmental groups.

In general, these stakeholders concluded that gasoline can meet the same low emission performance standards as RFG without the use of oxygenates. Butagricultural interests presented a potential obstacle to enacting legislation to remove the oxygen requirement. According to the U.S. Department of Agriculture, roughly 20% of the nation’s corn crop is used to produce the competing oxygenate, ethanol. If MTBE use were reduced or phased out, but the oxygen requirement remained in effect, ethanol use would have soared, increasing demand for corn. Conversely, if the oxygen requirement were repealed, not only would MTBE use decline, but so, likely, would demand for ethanol. Thus, some Members of Congress and governors from corn-growing states took a keen interest in MTBE legislation and related oxygenate requirements.

To help promote the market for ethanol if the oxygen standard were eliminated, a renewable fuels standard (RFS) was suggested. This would require that all gasoline contain ethanol or other renewable fuel. This concept was supported by agricultural interests, the oil industry, and some environmental groups. Opponents included states that do not produce ethanol, due to fears that the mandate could raise gasoline prices.

The Energy Policy Act of 2005 (P.L. 109-58) contains numerous MTBE and ethanol provisions. It repealed the Clean Air Act requirement to use MTBE or other oxygenates. In place of this requirement, the law established a renewable fuels standard. Under the RFS, annual gasoline supply is required to contain 7.5 billion gallons of ethanol or other renewable fuel by 2012. To prevent “backsliding” on air quality, the law requires that reductions in emissions of toxic substances achieved by RFG be maintained, and it authorizes funds for MTBE cleanup.

Issues in the Spring/Summer of 2006: MTBE Phase-Out and
Ethanol Supply

As a result of P.L. 109-58, the oxygen requirement for RFG was eliminated on May 6, 2006. This requirement — which gasoline suppliers asserted was a de facto mandate to use MTBE — was cited by gasoline suppliers as a defense against liability for MTBE contamination. Therefore, although P.L. 109-58 actually gave the industry more flexibility, the industry moved quickly to eliminate MTBE from the gasoline supply in spring 2006. Because MTBE accounted for 11% of the volume of RFG in areas where it was used, the elimination of MTBE increased pressure on already tight refining capacity. The loss in volume and energy from eliminating MTBE increased demand for gasoline as well as ethanol. Exacerbating the problem was the fact that the industry was making the transition from winter gasoline to more stringent summertime specifications, which adds competition for the highest-quality gasoline components. These pressures, along with historically high crude oil prices, led to historically high gasoline prices. Further, some localized areas (e.g., Norfolk, VA) faced short-term supply disruptions as refineries made the transition.

Cellulosic Biofuels

Ethanol, the most significant biofuel in the United States, is usually produced from corn. However, corn is a key animal feed, and is also used for human consumption. Further, corn is a resource-intensive crop, requiring significant use of chemical fertilizers and generally grown on prime farmland. There is growing interest in developing biofuels that require less energy to produce and have a smaller environmental footprint.Biofuels produced from cellulosic materials such as fast-growing trees, prairie grasses, or agricultural wastes are seen as a potential strategy for reducing the environmental impact of biofuels while expanding the United States’ ability to displace petroleum fuels. The potential supply of these feedstocks is abundant, which is why it is expected that future expansion of the U.S. biofuels industry will be in this area.

However, breaking down cellulose and converting it into fuel requires complex chemical processing. Starches (such as corn) and sugars (such as cane sugar) are easily fermented into alcohol, while cellulose must be broken down into sugars or starches through enzymatic or thermochemical processes before fermentation. Alternatively, biomass can be converted into synthesis gas, which can then be used to produce fuels. Regardless of the pathway, processing cellulose into fuels is currently prohibitively expensive relative to other conventional and alternative fuel options. Therefore, R&D has focused on lowering the costs of enzymatic and other processing techniques.

Further, questions remain about the feasibility of these fuels, as well as the ultimate environmental footprint — many of the proposed feedstocks have never been grown on a large scale. Therefore, R&D is also focused on increasing the yield of potential biofuel crops, developing harvesting techniques, and finding ways to limit the environmental impact of dedicated energy crops.

The Energy Policy Act of 2005 includes provisions to promote the development of cellulosic biofuels. These include an authorization for increased research and development funding at the Department of Energy; grants, loans, and loan guarantees for the development of cellulosic biofuels; per-gallon incentives for the first 1 billion gallons of domestic production; and a mandate that gasoline contain at least 250 million gallons of cellulosic ethanol annually starting in 2013.

On December 20, 2006, President Bush signed the Tax Relief and Health Care Act of 2006 (P.L. 109-432). Among other provisions, this tax law establishes a 50% depreciation allowance for cellulosic ethanol plants placed in service before January 1, 2013, subject to certain limitations.

Ethanol Imports

Corn growers and ethanol producers are supportive of the renewable fuels standard because of its implications for higher corn and ethanol prices. However, concern over ethanol imports is growing among some stakeholders. Because of lower production costs and the availability of government incentives, ethanol prices in Brazil and some other countries can be significantly lower than in the United States. To offset the U.S. tax incentive that all ethanol (imported or domestic) receives, most imports are subject to a relatively small 2.5% ad valorem tariff, but more significantly an added duty of $0.54 per gallon. This added duty effectively negates the tax incentive for covered imports and has been a significant barrier to fuel ethanol imports.However, under certain conditions imports of ethanol from Caribbean Basin Initiative (CBI) countries are granted duty-free status. This is true even if the ethanol was produced in a non-CBI country. In this scenario, the ethanol is produced in another country (historically Brazil or a European country), dehydrated in a CBI country, then shipped to the United States. This avenue for imported ethanol to avoid the tariff has been criticized by some stakeholders, including some Members of Congress. With the establishment of a renewable fuel standard, as well as high U.S. gasoline and ethanol prices, there may be more interest in importing ethanol, either through CBI countries or directl from ethanol producers.

In addition to the concerns over imports of duty-free ethanol from CBI countries, there is growing concern that a large portion of ethanol otherwise subject to the duties is being imported duty-free through a “manufacturing drawback.” If a manufacturer imports an intermediate product, then exports the finished product or a similar product, then that manufacturer may be eligible for a refund (drawback) of up to 99% of the duties paid. There are special provisions for the production of petroleum derivatives. In the case of fuel ethanol, the imported ethanol is used as a blending component in gasoline, and jet fuel (considered a like commodity) is exported to qualify for the drawback. Some critics estimate that as much as 75% or more of the duties were eligible for the drawback in 2006. Therefore, critics question the effectiveness of the ethanol duties and the CBI exemption.

On December 20, 2006, President Bush signed the Tax Relief and Health Care Act of 2006 (P.L. 109-432). Among other provisions, the act extended the duty on imported ethanol through December 31, 2008.

Vehicle Purchase Requirements

The Energy Policy Act of 1992 established mandatory alternative fuel vehicle purchase requirements for various vehicle fleets. Under the law, 75% of the passenger vehicles purchased by federal and state vehicle fleets must be capable of operating on alternative fuels; 90% of the vehicles purchased by alternative fuel providers must be alternative fuel vehicles.The alternative fuel vehicle provisions of EPAct 1992 have been criticized as ineffective because, while EPAct 1992 requires the purchase of vehicles, it did not mandate the use of alternative fuels. In most cases, the vehicles purchased to meet the requirement are dual-fuel vehicles (i.e., they can operate on either a conventional fuel or an alternative fuel). Those vehicles are primarily fueled using gasoline, because gasoline tends to be less expensive and more widely available than alternative fuels since the infrastructure to provide alternative fuels is limited compared with the existing infrastructure for gasoline and diesel fuel. In addition, despite the vehicle purchase mandate, many agencies have failed to meet their statutory obligation. As a result, in 2002 the Center for Biological Diversity filed a lawsuit with the U.S. District Court for the Northern District of California. In July 2002, the court ruled that several federal agencies failed to meet their quotas and ordered those agencies to prepare reports on their compliance with EPAct, which those agencies have completed.

The Energy Policy Act of 2005 (Section 701) modified the requirements for EPAct 1992 compliance. All dual-fuel vehicles purchased to meet the EPAct quotas are required to operate on alternative fuels, unless an agency is granted a waiver by the Secretary of Energy. In addition, the Secretary of Energy is required to conduct a study of the effectiveness of the EPAct requirements. Further, Section 703 of EPAct 2005 allows state and fuel provider fleets to petition the Department of Energy (DOE) to waive the vehicle purchase requirement if the fleet certifies other fuelsaving measures (e.g., using higher-efficiency conventional vehicles or hybrids).

In addition to the requirements for federal, state, and fuel provider fleets, EPAct 1992 grants the DOE the authority to extend the requirements to local government and private fleets. However, as of 2002, DOE had not made a determination on requirements for local and private fleets. As part of the above lawsuit, the Center for Biological Diversity also asked the court to force DOE to promulgate new rules. In ruling on the above case, the U.S. District Court for the Northern District of California ordered DOE to establish a timeline for a new rulemaking. DOE compiled a timeline and, on March 4, 2003, it issued a rulemaking determining that such a program would not promote the goals of EPAct, neither reducing dependence on foreign oil nor leading to greater use of alternative fuel vehicles (68 Federal Register 10319).

Vehicle Purchase Tax Incentives

Some supporters of alternative fuel and advanced technology vehicles argue that tax incentives for the purchase of vehicles and fuels are more effective than any purchase mandate. In addition to the mandatory purchase requirements, EPAct 1992 established tax incentives for the purchase of electric vehicles and “clean-fuel vehicles,” including alternative fuel and hybrid vehicles. The Energy Policy Act of 2005 (Section 1341) significantly expanded and extended the vehicle purchase incentives, establishing tax credits for the purchase of fuel cell, hybrid, alternative fuel, and advanced diesel vehicles. For passenger vehicles, the credit is worth as much as $3,400 for hybrids and advanced diesels, and as much as $4,000 for alternative fuel vehicles, depending on vehicle attributes. The expiration date for the incentives also varies depending on the technology.In the case of hybrid and advanced diesel vehicles, the number of vehicles eligible for the credit is limited for each vehicle manufacturer. Starting the second calendar quarter after a manufacturer sells the 60,000th vehicle eligible for the credit, the credit for that manufacturer’s vehicles is reduced. Currently, only Toyota has sold enough vehicles to trigger a phaseout. For Toyota (and Lexus) hybrids purchased after September 30, 2006, the credit is reduced by 50%; the credit is reduced to 25% for vehicles purchased after March 31, 2007, and is zero for vehicles purchased after September 30, 2007. Other manufacturers have yet to hit the 60,000 vehicle mark.

Biodiesel

Biodiesel is a synthetic diesel fuel produced from oils, including soybean and canola oils, animal fats, and recycled cooking grease. It can be blended with conventional diesel fuel and used in diesel engines with few or no modifications. Further, with some engine modifications, it can be used in a nearly pure form. Because biodiesel can displace conventional diesel without the use of new (and in many cases costly) vehicles, there is growing interest in its use. Further, because it can be produced from agricultural products, farmers (especially soybean and canola farmers) and some environmentalists have a keen interest in its development as a way to promote rural economies, reduce agricultural wastes, and limit greenhouse gas emissions. However, biodiesel production is currently expensive: wholesale biodiesel from virgin oils can cost up to two times more than conventional No. 2 diesel; biodiesel from recycled grease is less expensive but still costs considerably more than conventional diesel.The cost barriers for biodiesel production have generated interest in providing tax incentives for biodiesel, in the form of either a production tax credit or an excise tax exemption, or both. Further there is interest in developing new technologies to help reduce production costs. However, the organic oils used as raw materials are one of the largest costs in production. Therefore, to significantly reduce biodiesel production costs, the costs of soybean oil and other oils would need to decrease substantially.

As was stated above, the American Jobs Creation Act provides a tax credit of up to $1.00 per gallon for the sale and use of “agri-biodiesel” — biodiesel from virgin agricultural products. The credit is $0.50 per gallon for biodiesel from recycled grease. In addition, the law provides an excise tax credit for biodiesel blends (i.e., biodiesel and conventional diesel). Producers are eligible for one credit or the other, but not both (see “Fuel Tax Incentives,” above). These credits were set to expire at the end of 2006; the Energy Policy Act of 2005 (P.L. 109-58) extends these credits through 2008. Further, EPAct 2005 established a credit of $0.10 per gallon for small agri-biodiesel producers.

Hydrogen and Fuel Cells

Over the past few years, interest has grown substantially in hydrogen fuel and fuel cells. Hydrogen fuel can be produced using any energy source, and has thus been touted as a way to limit dependence on energy imports. Further, when hydrogen is used in a fuel cell (a device that produces electricity by converting hydrogen to water), mostly heat and water are produced, drastically reducing or eliminating vehicle emissions. However, hydrogen fuel production is currently very expensive, as are fuel cells. In addition, depending on the original fuel source, overall fuel-cycle emissions can be a key concern.Because of the potential benefits from hydrogen and fuel cells, and because of the existing technical and cost barriers to their commercialization, the Bush Administration has strongly supported research and development (R&D). In January 2002, the Administration announced the FreedomCAR initiative, which promotes cooperative R&D between the “Big Three” American auto manufacturers (DaimlerChrysler, Ford, and General Motors) and the federal government. While the partnership is conducting research on many technologies, hydrogen and fuel cell vehicles are a key focus. Further, in his January 2003 State of the Union address, President Bush announced the Hydrogen Fuel Initiative, which increased federal spending on hydrogen fuel and stationary fuel cell R&D. Overall, the President is requesting $1.8 billion between FY2004 and FY2008 for both initiatives, including a $720 million increase in funding from earlier appropriations.

Opponents of the initiatives argue that hydrogen fuel and fuel cells may never be commercialized and that the initiatives draw funding away from near-term technologies such as hybrid vehicles. Further, some argue that research and development alone will not reduce petroleum dependence and that Congress should instead consider tightening fuel economy standards for all vehicles.

Congress agreed to increase funding for hydrogen and fuel cell research from $185 million in FY2003 to $266 million in FY2004, $305 million in FY2005, and $335 million in FY2006. The Energy Policy Act of 2005 authorizes a total of $3.3 billion through FY2010 for fuel cell and hydrogen R&D.

Hybrid Vehicles

Hybrid gasoline/electric (and diesel/electric) vehicles are becoming increasingly popular in the United States. Hybrids combine a gasoline (or diesel) engine with an electrical motor system to improve efficiency. If their use becomes more widespread, they could help improve the overall efficiency of the vehicle fleet and could help limit oil consumption. Further, they could do so without significant changes to existing infrastructure, which has been a key barrier to the expanded use of alternative fuel vehicles. By the end of 2007, Ford, DaimlerChrysler, General Motors, Honda, Nissan, and Toyota will offer vehicles with hybrid powertrains. At the present time, only hybrid passenger cars, SUVs, and pickups are available in the United States, but hybrid versions of other vehicle models and classes are expected in the near future.

Because of their energy and environmental benefits, some states have provided drivers of hybrid vehicles an exemption from high occupancy vehicle (HOV) lane requirements. Under TEA-21 (which expired on September 30, 2003), states had the authority to grant HOV exemptions for so-called “Inherently Low Emission Vehicles” (ILEVs). The ILEV standard requires that a vehicle have no evaporative emissions, a standard that is not met by any current hybrid. However, because of the
reduced emissions and improved fuel economy of hybrid vehicles, there has been congressional interest in explicitly granting states the right to exempt them from HOV lane requirements. While not addressing hybrids directly, the final version of the highway reauthorization act (P.L. 109-59) permits states to exempt certain highefficiency vehicles from HOV restrictions.

Further, as was stated above, the Energy Policy Act of 2005 expanded the incentives for the purchase of hybrid vehicles (see “Vehicle Purchase Tax Incentives,” above).

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